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MUMBAI: Finance minister P Chidambaram has told the chief executives of state-owned banks not to be obsessed with higher margins and instead attract borrowers with lower interest rates. Bank managements, according to him, should be happy with a 3% margin - a suggestion that has not gone down too well with bankers.

Higher net interest margins, or NIM, - a key financial parameter that analysts track to judge the health of lenders - only indicate that banks are not passing on the benefits of lower rates to their borrowers. This was spelt out by the minister in a recent closed-door meeting in Delhi with PSBs chiefs.

The NIM of a bank is the difference between the interest earned (on loans and investments) and interest paid to depositors (and other lenders to the bank) relative to the average interest earning assets during a specific period, like a quarter or a year, and is expressed as a percentage. But it's not a measure of total profitability as banks earn fees and other non-interest income.

The minister said several overseas banks are able to show a healthy profit growth with 2% margin. But, Pratip Chaudhuri, chairman of the country's largest lender State Bank of India, disagreed. He said the margins of Indian banks would be similar to that of overseas banks if the provisions for bad loan are factored in while arriving at NIM. He said unlike Indian banks most international banks add the cost of provision to calculate NIM - a practice that lowers the margin. The total bad loans, net of provisions, of all commercial banks were 64,900 crore on March 31, of which the share of PSU banks is around 36,000 crore.

But, the finance minister stood his ground on NIM, said bankers present at the meeting. "An NIM of 3% is good for the economy. When a businessman is borrowing, he always looks at the rate of interest to decide on the viability of the project," he said.

Soon after the quarterly performance announcement of Dena Bank, a PSU lender, its chairman and managing director Nupur Mitra said, "If banks have higher margins, it would mean either they are lending to riskier projects where they are earning a very good rate of interest on loans or they are making good profit without passing it to borrowers."

Another banker who attended the meeting said the finance minister was trying whatever he could to kick-start the economy. "He has asked banks to increase lending to consumer goods, give a helping hand to builders with incomplete residential projects. In this context, he has asked them to lower deposit cost and pass on the benefit of lower rates to borrowers," he said.

"It is not fair to compare NIMs of Indian banks with banks operating overseas because banks in India have to maintain reserve ratios," Hemindra Hazari, head of research (institutional equities) at brokerage Nirmal Bang Equities, said. "Therefore, it is only fair to compare the interest spread of foreign banks operating in India with those of Indian banks."

The interest spread is the difference between the interest yield (on advances and loans) and interest paid on borrowed funds.